Investors must act cautiously during a recession. They must monitor the market carefully and try to identify opportunities to purchase high-quality assets at discounted prices. As per Kavan Choksi, while recession can be quite chaotic for the market, they also coincide with the best opportunities. Investors who want to make the most of this market situation should put emphasis on investing in high-quality companies with strong balance sheets and are linked to industries that historically do well during tough economic times.
Kavan Choksi provides insight into how diverse types of stocks behave during a recession
Having a good understanding of the assets to avoid investing in during a recession is just as important as having the knowledge of companies where one should invest in. Broadly speaking, the highly leveraged, cyclical, or speculative companies and assets are the ones with the biggest risk during a recession.
Most investors would be smart enough to steer clear of highly leveraged companies that have huge debt loads on their balance sheets during a recession. Such businesses commonly suffer under the burden of too high-interest payments that eventually leads to an unsustainable debt-to-equity (DE) ratio.
In addition to struggling to make their debt payments in time, highly leveraged businesses are commonly faced with a decrease in revenue brought about by the recession. A precipitous drop in shareholder value or even the precipitous drop in shareholder value is much higher in such companies than the ones with lower debt loads.
Cyclical stocks are often linked with consumer confidence and employment. However, both of these factors suffer during a recession. Cyclical stocks tend to do pretty well during times of boom when consumers have more discretionary income to spend on luxury items and nonessential goods. However, as the economy falters, a large number of consumers cut back their spending on such discretionary expenses. It is especially common to lower expenses of travel, restaurants, and leisure services during a recession. As a result, the cyclical stocks in these industries may significantly suffer, making them a less attractive investment tool.
Speculative stocks are pretty richly valued on the basis of optimism among the shareholder base. But this optimism gets tested during recessions. In fact, such assets are typically the worst performers in a recession, and investors must avoid them during economically turbulent situations. As per Kavan Choksi, speculative stocks have not proven their value yet and are commonly considered to under-the-radar opportunities by investors who are exploring options to get in on the ground floor of the next big investment opportunity. Such high-risk stocks are often the fastest to fall during a recession, as investors pull out their money and pivot to safe-haven investments that limit their exposure during market turbulence.
Basically, investing in highly leveraged, cyclical, and speculative stocks can be very risky for investors during recessions, as such companies may get bankrupt. However, even though it can be tempting to get through the recession without any exposure risk, investors may lose valuable opportunities by maintaining such an approach. After all, there are companies that do well during economic downturns.